DEALMAKER GUEST BLOG -- JIM HILL

M&A has turgid start in ’13, but what’s next depends on sellers

Blog Entry: February 20, 2013 4:30 AM | Author: JIM HILL

Jim Hill is the executive chairman of Benesch, chair of the firm's private equity group and an active and practicing member of its corporate and securities practice group. He focuses his active practice on publicly and privately held growth companies in addition to representing mezzanine finance providers and equity participants.

The fourth quarter of 2012 brought a sigh of relief to investment bankers, senior and mezzanine lenders and strategic and financial buyers as the pace of deals quickened, due in large part to looming capital gains tax changes coming in the dawn of 2013.

But that relief quickly turned to deep concerns in the deal community because the deal pipeline for both strategic and financial buyers became nearly empty with few great prospects in sight for the first quarter of 2013.The question that must be asked is: Why is this the case, with leverage being so abundant for leveraged buyouts, interest rates being so low and with so little inventory? Wouldn’t this be a great time to be a seller given the law of supply and demand?To be sure, the capital overhang in the U.S. private equity world alone that will burn out, if not committed to investments in the next two years, is about $280 billion. What that means is you, as a principal of a private equity firm, have capital commitments from your limited partners that are usually of a five-year term. If that money isn’t invested, then it goes back to the limited partners, and you cannot earn your 2% asset management fee on those dollars. So, the incentive is in place to invest.

Also, U.S. corporate entities that are not owned by private equity have balance sheets of more than $2 trillion of cash that is available in most instances for acquisitions. Given the continued slow pace of organic growth in almost every industry, value creation must be driven by acquisition.

So, why so few sellers, and will that change? Answers to the first question include:

1. Sellers’ continued concerns about the sustainability of their earnings for their companies, thus possibly achieving a lower purchase price in a sale process.

2. Private sellers, who are not sponsored, feeling that even if their internal company return on equity is single digits today, it is still a better return than what they can do with the proceeds of a sale after paying their transactions costs and taxes.

3. Potential sellers looking over the remains of the 2012 landscape of auction sales, where, in many instances, “busted auctions” occurred due to companies either not hitting their earnings forecasts or actual pricing not being as high as the seller would expect.

What may and can change this current state of semi-paralysis would be a) strategic buyers deciding that acquisition growth is a key way to create shareholder value today as organic growth remains challenging, b) private equity firms having to spend the capital commitments they have been given and c) perhaps sellers realizing that their 2013 earnings are better than 2012 (not on a “hockey stick” uptick) and positive enough to sell a business that has either or both succession challenges and industry consolidation challenges as the “big get bigger” in their markets.

Why should the general public care if the 2013 uptick does or does not happen? Well, many companies are cash constrained due to their inability to borrow more senior debt to grow despite their working capital needs. Further, many other companies are capital constrained from making the physical improvements to their operations that must be made to remain competitive within their industry and the world markets. If they do not sell or recapitalize their business, these events (which also create jobs) will not occur.

So, for transactional folk, harder work is demanded in 2013 that will be beneficial to all.

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